FARGO - At the recent annual meeting of the Renewable Fuels Association, three legislative priorities were outlined for 2010. These were removing the blend wall, encouraging the Environmental Protection Agency to reconsider its calculation on indirect land use and keeping the industry's ethanol subsidy, which is commonly known as the blenders tax credit.

The blenders tax credit is a key issue because the program is set to expire on Dec. 31, 2010, unless Congress decides to extend it. Presently, the ethanol blenders credit is 45 cents per gallon. It used to be 51 cents per gallon but was reduced after Jan. 1, 2009.

Extension of the ethanol subsidy is highly questionable. Just recently, Congress failed to extend the biodiesel tax credit. While many factors impact the profitability of biodiesel production, this certainly is one reason why the nation isn't producing any biodiesel at the moment, as all existing production facilities are idled. Rising federal budget deficit pressures also will make it challenging for Congress to extend either the biodiesel or ethanol tax credit.

To determine the importance of the ethanol blenders credit to individual ethanol plant profitability and bankruptcy risk, a simulation model was constructed and calibrated with average monthly revenue and cost data for a typical Iowa 100 million gallons per year ethanol plant from 2005 to the present. These data are updated monthly by the Agricultural Market Research Center at Iowa State University.

The study focused on a plant's ability to pay operating, labor, financing and property tax expenses. If these expenses are not paid, an ethanol plant is not viable long term because suppliers, employees, lenders or local governments would force the firm into bankruptcy for not meeting its financial obligations.

From January 2005 to the present, average returns over those expenses

listed above averaged 52 cents per gallon of ethanol produced. At this level of profitability and known price risks in the industry, the simulation model calculated that the risk of bankruptcy was 3 percent. Given that there are 200 ethanol plants nationwide, this would imply six bankruptcies. This compares with the actual rate of more than a dozen bankruptcy filings in 2009. However, a number of those failures are back in operation after financial restructuring. Therefore, this benchmark was assumed to validate the model as being reflective of industry experience.

The next step was to ascertain the impact of removing the subsidy. This was modeled by deducting 45 cents per gallon from gross revenue for each gallon of ethanol sold. It is unknown how the benefit of the blenders tax credit actually is shared among blenders, gasoline consumers and ethanol plants. Increasingly, ethanol plants and blenders are jointly owned by the same petroleum company. Recent studies from Cornell and Purdue also find that ethanol plants capture most of the subsidy. Therefore, the total amount of the subsidy was directly deducted.

The model results from January 2005 to the present show returns over the expenses listed were reduced to 7 cents per gallon when the blenders tax credit subsidy was removed. The risk of bankruptcy rose to 52 percent. This is a 16-fold increase from baseline conditions and jeopardizes an ethanol plant's financial well being.

The 16-fold increase is large for two important reasons. First, the denominator of the equation is small, so any increase in bankruptcy risk will be of significant magnitude. More importantly though, the ethanol business is highly competitive and generally operates on thin margins. During the past five years, the costs examined in this study constituted 77 percent of total gross revenue. Consequently, any cost increase or reduction in revenue has a substantial impact on bottom line profits.

One fixed cost excluded from the analysis was depreciation. For the typical plant in this study, depreciation averages 12 cents per gallon. If the blenders credit is not extended and industry returns are only 7 cents per gallon, plants do not have sufficient cash flow to rebuild or replace equipment as it wears out. Eventually, ethanol plants will have so much dilapidated equipment that they will be unable to function. Moreover, this poses an even greater threat in the future as many plants are striving to increase efficiency and undertake even greater new investment cellulosic technologies. Sufficient profits and residual cash flow would not be available internally to finance the adoption of these technologies.